AAPL, QCOM Losers As Smartphones Approach ‘Exhaustion,’ Says Citi

By Tiernan Ray

In a longish (36 pages) report today on mobile computing, Citigorup‘s Glen Yeung and colleagues Kota Ezawa, Kevin Chang, Arthur Lai, Terence Whalen, Jim Suva, Henry Kim, Amit Harchandani, and Roland Shu opine that sales of smartphones have moved past earlier stages of “explosion” and “destruction” to a state of “exhaustion,” marked by the slowing of demand for the most expensive smartphones, and “increasingly elusive” hardware innovation and falling prices.

Yeung & Co. assert that the global mobile handset count of 4.85 billion handsets in use will completely saturate developed markets by next year, and will saturate developing markets by 2016, based on an extrapolation of research by the International Telecommunications Union.

With an adult population of 1 billion in developed markets, and a handset base of 1.4 billion units, developed markets now have 143% as many handsets in circulation as there are grown people capable of owning them. Emerging markets, by contrast, are a 103.8% “penetration.”

Looking at numbers for mobile broadband subscriptions, he sees developed markets hitting a peak in mobile growth in 2014, with more opportunity in emerging markets:

In developed countries, penetration of mobile broadband subscriptions is an already high 75%, well above the global figure (30%). Extrapolating near-term growth rates, 100% saturation in developed markets will be achieved in 2015. If we were to use carrier estimates of peak penetration (85%), then peak penetration in developed markets will be achieved in 2014. However, in developing countries, penetration is a mere 20%, suggesting more room for growth in these markets. Notably, based on the steeper trajectory of mobile broadband subscription growth (51% 2013/2012 estimated), in developing markets full saturation is expected to be reached by 2017. If we were to use carrier estimates of peak penetration (85%), then peak penetration in developing markets will be achieved in 2016.

Yeung and the team opine that the smartphone market, now in an “expansion” phase, will go through a traditional decline in prices, which is the thing that drives acceleration in units:

In order to achieve the steep rate of adoption associated with such expansion, we assert that smartphone ASPs will need to fall, further moderating industry revenue growth. To make this point, we look at two adjacent markets (notebook PCs & feature phones) to provide a glimpse at what we believe is typical hardware technology unit/ASP evolution.

Taking Apple‘s (AAPL) iPhone as the main example for smartphones, Yeung writes that “smartphone evolution has been characterized by integration (of old economy devices) rather than innovation” since the iPhone came out, including swallowing GPS, MP3 players, cameras, etc., and that “while we applaud Apple for truly innovating with the introduction of the iPhone in 2007, we argue that innovation in smartphone hardware from here is increasingly difficult.”

“With a plethora of mobile devices already integrated, we question if there are
any mobile devices left to integrate,” he asks, and answers, “there are few discrete devices left to integrate.”

The result is the maturity of the smartphone market, and the rise ofsoftware and services:

Smartphone hardware is following the typical pattern of diminishing marginal utility and may be approaching the point of near-zero marginal utility (this incidentally puts the onus of incremental utility on software & services). Said differently, we argue that smartphone hardware may be “good enough” at least at this point in time.

The stock implications are rough for both handset makers and for chip makers, the team write. For Apple, whose shares he rates Neutral, the company faces the challenge of the rising pace with which it and every competitor are being forced to rush new models to market.

“This high cadence of new products introduces the risk of poor yield,” he argues. “Indeed, iPhone5 is a primary example of this.”

“While it may be argued that yield issues are temporary on any given device, we view the risk of yield issues as increasing as produce cadence accelerates.”

For BlackBerry (BBRY), rated Sell, “The increase innovation by other smartphone OEMs increases the risk that Blackberry may need to cut its pricing at an accelerated rated as well as increase its product innovation, both of which would put pressure on the company’s margin.”

Yeung’s colleague Ezawa thinks Toshiba (6502JP), Sony (SNE), and Panasonic (6752JP) are all relatively appealing, rating each one’s shares a Buy, because they already went through pain:

Japanese electronics makers were among the first to experience the damage caused by contraction in the monetary value (contraction in market value) in digital consumer electronics that we analyze in this report and have already escaped from their crises. While there issues and concerns remain, we find Japan’s electronics makers relatively appealing investments.

Yeung cut his price target to $70 from $81, writing that Qualcomm’s valuation will suffer as growth slows:

Qualcomm denies that saturation will impact growth. We would argue however, that even if Qualcomm has visibility on growth, already high saturation rates points to eventual growth deceleration. Perhaps more relevant, we view this deceleration of growth as a limiting factor in Qualcomm’s multiple, particularly when using the example of the PC sector (Intel (INTC) within it) as an example. As we illustrate below, when the PC sector went into deceleration mode, Intel’s multiple began to fall.

He offers the following table of Intel’s decrease in valuation over 15 years:

Qualcomm stock today is up 41.61, or 2.6%, at $63. Apple shares are down a penny at $440.50.

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There are 24 comments

JULY 25, 2013 1:19 P.M.

Anonymous wrote:

Every single one of these guys should be fired for having no vision

JULY 25, 2013 1:30 P.M.

GaryDMN wrote:

Smartphone's are not a once in a lifetime buy, people buy new ones every year or three. The bigger the smartphone gets, the bigger the next buying cycle will be. The smartphone market will continue to grow, unless people stop buying smartphones completely, which won't happen until something comes along to obsolete smartphones. This bodes well for Apple due to the loyalty of their customer base and the stickiness of the Apple ecosystem.

JULY 25, 2013 1:33 P.M.

Frank Cout wrote:

The key about BB is they saw this trend 18 months ago, Mobile computing will be the next big innovation for smartphones, For that they needed an OS that could support that, BB10 based on QNX tech, Your phone will have all you computer power and you will connect peripheral to it, like a desktop screen, a tablet like screen keyboard and mouse. At first in developing countries where wifi and computer are not in every household, mobile computing Phone will be very appealing. Than the cost saving of having 1 cpu and multiple screen option will catch on in the rest of the world. Also a big saving for Corporation where some employee have 3 Cpu phone laptop and tablet with 3 security licences, compare to 1 licences and different screen type option that don't require extra security software.

JULY 25, 2013 1:34 P.M.

MrSmith210 wrote:

Yeung’s colleague Ezawa thinks Toshiba (6502JP), Sony (SNE), and Panasonic (6752JP) are all relatively appealing, rating each one’s shares a Buy, because they already went through pain.

So we're back to buying TV stocks now instead of mobile related stocks because they "went through pain" ? Absolutely ridiculous thought process in my opinion. Do these guys REALLY think the smartphone/mobile industry is "exhausted" ? It's barely been alive since 2001. Unreal. To think these massive, multi-billion dollar companies are going to suddenly stop doing what they do? It's crazy.

JULY 25, 2013 1:36 P.M.

A Pull wrote:

Who of the handset makers offers services/software in order to survive the commodification of the smart phone? Anybody?

JULY 25, 2013 1:40 P.M.

John wrote:

I hate to pop their bubble but even if the "market" is saturated with smart phones and iPhones the technology will still continue where a newer model with more features will always be wanted. Those who can afford it will replace every cycle to be on the cutting edge. Those who can't afford a new phone will allow more time between smart phones and iPhones. Those that can afford an iPhone will buy them as they are the best and integrate seamlessly with other Apple devices. Those who can't afford the best will buy the Android devices which, while adequate, just are not the best. But to say the market is "saturated" when Apple sales of iPhones increased by 20% YOY is foolish. And there is a very big world out there. I would say these guys started with a pre-conceived notion or an agenda and then wrote their piece. It's worth exactly what I paid for it - and a waste of time reading. So much for Citi and their analysts. Again, what is their agenda?

JULY 25, 2013 1:41 P.M.

John Strom wrote:

I hate to pop their bubble but even if the "market" is saturated with smart phones and iPhones the technology will still continue where a newer model with more features will always be wanted. Those who can afford it will replace every cycle to be on the cutting edge. Those who can't afford a new phone will allow more time between smart phones and iPhones. Those that can afford an iPhone will buy them as they are the best and integrate seamlessly with other Apple devices. Those who can't afford the best will buy the Android devices which, while adequate, just are not the best. But to say the market is "saturated" when Apple sales of iPhones increased by 20% YOY is foolish. And there is a very big world out there. I would say these guys started with a pre-conceived notion or an agenda and then wrote their piece. It's worth exactly what I paid for it - and a waste of time reading. So much for Citi and their analysts. Again, what is their agenda?

JULY 25, 2013 1:44 P.M.

John wrote:

The PC market didn't decelerate due to saturation -- in fact, folks were buying new PCs all the time for years as their older ones didn't keep up with the performance curve. The PC market decelerated when alternatives became available. (Such as tablets, which overlap significantly with the PC in capability as exercised by the average user.)

What is the alternative to smartphones and tablets -- the new device which will slow the smartphone/tablet market down? I haven't seen it yet, and I work in the industry.

JULY 25, 2013 1:54 P.M.

@frank wrote:

bbry is going NOWHERE and fast!

game was over for them several years ago, yet you say that bbry had the vision of 'mobile computing' 18 months ago so bbry will be the 'leader"?

yeah, right. they will be lucky to be around 18 weeks from now to capitalize on their 'vision'

btw, the term 'mobile computing' has been around for a decade at least.

finally, BBRY is DOA. say it as your mantra as you're gonna have to get used to reality.

JULY 25, 2013 2:03 P.M.

Jake_in_Seoul wrote:

Yeung's estimate for iphone sales last quarter was 17 million units vs. the actual 31.2 million, only 95% off :), the worst of any analyst Phillip Dewitt surveyed. I'm not sure 1) why he still has a job and 2) why we should now pay attention to him or his colleagues.

JULY 25, 2013 2:08 P.M.

William wrote:

Of course, this useless report was written before Apple announced it has sold 31 million iPhones in the last quarter.

JULY 25, 2013 2:13 P.M.

Anonymous wrote:

These is one more dumb article from Citi Analyst. Glen has always been wrong on his forecasts. Recent quarter Apple sold 20% more iPhones then a year ago. Most of the time iPhones sell the latest iPhones in the Quarter it is released

If you notice in the December 2012 quarter Apple sold 47.8 Million iPhones and most of them were iPhone 5S. In the second Quarter Apple Sold 37.4 Million iPhones and most of them were iPhone 5S and the 3rd quarter Apple sold 31.2 Million iPhones and there was a mix of iPhone 5S, iPhone 4S & iPhone 4.

When Apple releases the iPhone 5S in the first quarter of 2014, the iPhone 5S will be the most iPhones sold.

The margin has moderated around 38% for the last 4 quarters. Apple's average price for the last few quarters is around $620. Apple has not entered the midrange of the market as yet. Presently Samsung & iPhone has 100% profit in the smartphone segments as per research reports. Samsung profits in Smartphones is 10-12 billion dollars. iPhone's profit is around 20-22 billion dollars in the smartphone segment. Presently AAPL has 66-70% of the profit in the smartphone segment selling only in the high end segment. If AAPL start selling in the midrange $300-$400 range, they will definitely take profit share from samsung.

Software services growth is around 30% presently. iWatch, Apple TV and other products will definitely help AAPL maintain the margins around 38%. AAPL still has 90% retention rate with their present customers. AAPL still has 575 million Customers on file which is 30% more than the same time last year. 2014 would be a very good year for AAPL.

JULY 25, 2013 2:17 P.M.

Mike wrote:

These guys either were short QCOM and got made or long FB and wanted the spotlight on it.
QCOM is being hit by all sides the last few weeks for no reason.
Earnings just prove how powerful QCOM is and will be for years to come.

JULY 25, 2013 2:18 P.M.

Sam wrote:

These is one more dumb article from Citi Analyst. Glen has always been wrong on his forecasts. Recent quarter Apple sold 20% more iPhones then a year ago. Most of the time latest iPhones are sold in the Quarter it is released

If you notice in the December 2012 quarter Apple sold 47.8 Million iPhones and most of them were iPhone 5S. In the second Quarter Apple Sold 37.4 Million iPhones and most of them were iPhone 5S and the 3rd quarter Apple sold 31.2 Million iPhones and there was a mix of iPhone 5S, iPhone 4S & iPhone 4.

When Apple releases the iPhone 5S in the first quarter of 2014, the iPhone 5S will be the most iPhones sold.

The margin has moderated around 38% for the last 4 quarters. Apple's average price for the last few quarters is around $620. Apple has not entered the midrange of the market as yet. Presently Samsung & iPhone has 100% profit in the smartphone segments as per research reports. Samsung profits in Smartphones is 10-12 billion dollars. iPhone's profit is around 20-22 billion dollars in the smartphone segment. Presently AAPL has 66-70% of the profit in the smartphone segment selling only in the high end segment. If AAPL start selling in the midrange $300-$400 range, they will definitely take profit share from samsung.

Software services growth is around 30% presently. iWatch, Apple TV and other products will definitely help AAPL maintain the margins around 38%. AAPL still has 90% retention rate with their present customers. AAPL still has 575 million Customers on file which is 30% more than the same time last year. 2014 would be a very good year for AAPL.

JULY 25, 2013 2:26 P.M.

Seth Trundle wrote:

Evidently, these "experts" do not have teenaged and 20-somethings in their lives or they would realize that these age groups are constantly buying the latest technology and live their lives on mobile social media.

JULY 25, 2013 3:02 P.M.

bigdeal wrote:

This whole analysis is based on PC analogy which to me is flawed. It is good to look back in history to predict future but not by ignoring every other fact in plain sight. The smartphone/tablet revolution is fueled by the desire to do all all these things - emailing, browsing, video, photos, texting ... in the palm of your hand both literally and figuratively. The PC was an overkill for all these tasks and the smartphones are the perfect replacement.
As long as we continue to push the envelope on the use of smartphones to do everything we do with a PC and internet ( even banking and watching movies) I really don't see this market slowing down or saturating soon. There is a lot of technological innovation left to make the smartphones and tablets more powerful and useful then they are today.

JULY 25, 2013 3:40 P.M.

Lee wrote:

I'm glad my broker is NOT with Citi...these analysts are clueless.

While 85% of folks may already have smartphones...they miss two key points.
1 - every year, there's a chunk of "kids" (at 10,11,12,etc years old) getting phones for the first time
That's about 10 million kids per year, and if 85% get smartphones...that's 8.5M new phones/yr just in the U.S.

2 - those of us with phones, tend to upgrade AT LEAST every other year on avg (some keep them longer, some upgrade sooner). But that too is also a NEW phone being sold to EXISTING smartphone users! Wow, how much are these analysts (over)paid?

the saturation applies more to the mobile service providers. I may get a new phone every two years, but I am still the same subscriber to AT&T. They only get new business through the kids getting phones (or folks that switch providers).

JULY 25, 2013 4:49 P.M.

@ Frank wrote:

Blackberry, MDM, BB10, and their "vision" et cetera and your message have as much chance of successfully selling and being relevant today as two porn stars from the 1950's making a comeback and performing a Tony nominated sellout show on a Broadway stage. Good luck.

JULY 25, 2013 6:50 P.M.

Ex RIM Fan wrote:

Sad to say, BB10 is dead before it will even get a chance.

Most IT managers and decision makers know this. Which is why they stayed away while the Z10 and Q10 sales flopped.

Now carriers are being forced to dump Z10s at 75% off to get rid of inventory. Who's going to invest large CAPEX on a company that is actively trying to break up and sell itself, and may not even be around in 3 years?

JULY 25, 2013 8:22 P.M.

Bill wrote:

Please include me in the large and rapidly growing camp which believes Yeung is a corrupt hack. If the vote were still open, and Citi could make money on it, that clown college would opine that the world is flat.

JULY 25, 2013 8:28 P.M.

Re BBRY wrote:

Jeffries' analyst Peter Misek was quoted today on the CBC website. He said the stock is currently priced at salvage value. According to him the company has to split into a software/services company and a handset maker before the end of the year. The longer they wait the more value deteriorates. The board must decide: either partner, sell or close the thing down or value will eventually hit zero.

He feels the potential value is anywhere between $5-$15. And he admits his sentimentality as a Canadian.

JULY 25, 2013 8:39 P.M.

Note Re Verizon Moving Into Canada... wrote:

BCE is seen reacting on the CBC and G&M. Takes out two page ad. BCE CEO George Cope claims unfair loophooes. 313 comments on the CBC website. Have never before seen so many Canadians unhappy and in this case it's with regards to being charged the highest telecomm fees in the world by BCE, Rogers and Telus. 98% of the comments welcomed the Canadian governments wish to have at least 4 major competitors in every market. Consumer advocacy groups say the industry will now change forever because competition is most welcome.

Go for it Verizon. You will have no problem out cheaping the big 3 by offering love us live us incentives. Seriously. And bring other corporate friends and partners. Federal finance minister has stated in the past that he could not understand what was substantiating such high prices in various sectors.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.